Controls Over the Financial Activities
of the Internal Revenue Service Oversight Board Need to Be Improved

August 2005

Reference Number: †2005-10-135

This report has cleared the Treasury Inspector
General for Tax Administration disclosure review process and information
determined to be restricted from public release has been redacted from this
document.

August
23, 2005

MEMORANDUM FOR
CHAIRPERSON, INTERNAL REVENUE SERVICE OVERSIGHT BOARD

FROM:†††† Pamela J. Gardiner /s/ Pamela J. Gardiner

†††††††††††††††† Deputy Inspector General for
Audit

SUBJECT:†††† Final Audit Report - Controls Over the
Financial Activities of the Internal Revenue Service Oversight Board Need to Be
Improved (Audit # 200410028)

This report presents the
results of our review of the financial management of the Internal Revenue
Service (IRS) Oversight Board. †The
overall objective of this review was to evaluate the extent and adequacy of
controls over the budgeting of funds, recording of transactions, and financial
reporting of the IRS Oversight Board.† We
also reviewed the IRS Oversight Boardís Fiscal Year (FY) 2004 financial
transactions. †This review was conducted
as a follow-on to our recently completed audit of the effectiveness of the Oversight Board.

The
Oversight Board was created as part of a series of reforms of the IRS included
in the IRS Restructuring and Reform Act of 1998 (RRA 98).† The Oversight Board was established as an independent
body responsible for providing the IRS with long-term guidance and direction. †The operation of the Oversight Board is funded
by the IRS based on a proposed budget submitted annually by the Oversight
Board.† The Department of the Treasury,
Departmental Offices (DO), provides administrative support to the Oversight
Board and advances it the funds necessary to meet its ongoing obligations.† The IRS subsequently reimburses the DO for
these costs quarterly.†

In
summary, the Oversight Board has significant weaknesses in its financial
management controls and needs to more effectively monitor its operating
funds.† Specifically, controls over the funding of Oversight Board operations, recording of financial transactions, and
reliability of financial management information need to be improved.† In addition, our review of the activity
reflected in the Oversight Boardís financial reports for FY 2004 identified a number
of instances where material financial transactions were not properly reflected.† In addition, quarterly billings to the IRS for the operation of the Oversight
Board were not
certified as to their accuracy by the Chairperson, Oversight Board, as
required.† While the Oversight Boardís FY 2004 budget of $1.5 million is not large
in comparison to the IRSí total budgetary resources of approximately
$11 billion, controls still need to be in place to properly manage and
account for Oversight Board operations.

Oversight Board members also
did not always adhere to Federal Government travel regulations when on official
business.† For example, Oversight Board members
received both a no-cost meal provided by the Federal Government and a per diem
cash payment for the same meal in 36 instances in FY 2004. †Federal Government travel regulations require
that travelers reduce their meals per diem whenever the Federal Government
provides meals at no cost. †

Finally,
in our opinion,
the Oversight Boardís apparent dependence on the IRS for approval of its annual
budget has the potential to adversely affect its independence and
effectiveness.† By being dependent on the
IRS for approval of its annual budget, the Oversight Board could be perceived
as being in conflict with its mandate to independently oversee the
administration and management of the IRS.†
The RRA 98 does not specify a
methodology for establishing the annual funding level of the Oversight Board.

We
recommended the Chairperson, IRS Oversight Board, develop procedures to require the routine review of
Oversight Board financial information for accuracy and the monitoring of open
aged obligations.† We also recommended
the Chairperson, IRS Oversight Board, ensure all requests for reimbursement are
reviewed and certified before submission. †Additionally, we recommended the Chairperson,
IRS Oversight Board, reinforce existing Federal Government travel guidelines
regarding meal reimbursement to all current members and ensure new and incoming
Board members are provided instructions on relevant Federal Government travel
regulations before they incur travel expenses. †Finally, we recommended the Chairperson, IRS
Oversight Board, request that a separate line item within the Department of the
Treasury budget be established for the Oversight Boardís funding.†

Managementís Response: †The
Chairperson, IRS Oversight Board, concurred with the recommendations in the
report.† Procedures have been developed
for Oversight Board staff to conduct a monthly review of all monthly cost
reports and identify misclassified items or expected but unreported
expenditures.† Procedures have also
already been developed for Oversight Board staff to conduct monthly reviews of
open aged obligations.† In addition, procedures
have been developed for Oversight Board staff to certify quarterly requests for
reimbursement submitted to the IRS.† The DOís
Travel Handbook has been distributed to all Board members and staff; it will be
incorporated into a Board Orientation Guide for new members.† Finally, the Chairperson, IRS Oversight Board,
will discuss with the Department of the Treasury appropriate mechanisms for
funding the IRS Oversight Board to assure its independence from the IRS.† Managementís complete response to the draft
report is included as Appendix V.

Copies of this
report are also being sent to the Congressional committees charged with
overseeing the IRS.† Please contact me at
(202) 622-6510 if you have questions or Daniel R. Devlin, Assistant Inspector
General for Audit (Headquarters Operations and Exempt Organizations Programs),
at (202) 622-8500.

On July 22, 1998, the President of the
United States signed into law a series of reforms for the Internal Revenue
Service (IRS) called the IRS Restructuring and Reform Act of 1998 (RRA 98).† The RRA 98 was enacted to improve the IRS so
it can better serve taxpayers.† In
addition to many changes in the IRS, the Act also called for creation of the
IRS Oversight Board, an independent body responsible to provide the IRS with
long-term guidance and direction.† The IRS Oversight Board consists of nine
members, including the Secretary (or Deputy Secretary) of the Treasury and the IRS
Commissioner.† The 7 other members are
appointed by the President, with the advice and consent of the Senate, for
5-year terms and are to be selected on the basis of their professional
experience and expertise.†The
Oversight Board is authorized to appoint staff; as of November 2004, it had five
staff members assisting in its duties, including a Staff Director and an
Administrative Support Officer.

The IRS Oversight Board is responsible for overseeing the
IRS in its administration, management, and application of the internal revenue
laws.† Its specific responsibilities
include:†

∑Reviewing
and approving IRS strategic plans, including the establishment of mission,
objectives, and standards of performance relative to either.

∑Reviewing
the IRSí operational functions, including plans for tax systems modernization,
outsourcing or managed competition, and training and education.

Overseeing management of the IRS through recommending
to the President candidates for appointment as the IRS Commissioner and,
if necessary, recommending the Commissionerís removal; reviewing the
selection, evaluation, and compensation of certain senior IRS executives
who have program management responsibility over significant functions; and
reviewing and approving the Commissionerís plans for any major IRS
reorganization.

Overseeing the IRSí budget through reviewing
and approving the Commissionerís budget request, submitting the budget
request to the Secretary of the Treasury, and ensuring the budget request
supports the IRSí strategic plans.

∑Ensuring
the proper treatment of taxpayers by IRS employees.

The IRS Oversight Board has an annual
operating budget that is funded by the IRS.†
The Department of the Treasury, Departmental Offices (DO), provides the administrative
support, such as the recording of financial transactions and preparation of
financial reports, necessary for the Oversight Board to function.† The DO also advances the Oversight Board the
funds necessary to meet its ongoing obligations.† The DO is subsequently reimbursed for these
costs by the IRS quarterly, based on an Interagency Agreement. †The Interagency Agreement specifies that the
IRS will reimburse the DO for all costs associated with the IRS Oversight
Board.† Payments to the DO are made
quarterly via the Intra-Governmental Payment and Collection System.† The Oversight Board had an operating budget
of $1.5 million in Fiscal Year (FY) 2004.

The RRA 98 requires the IRS Oversight
Board to include in its annual report to the Congress information on travel expenses
by Board members.† In FY 2003, the IRS
Oversight Board reported that it incurred $41,545 in travel expenses for its
members and staff for travel relating to Board activities; however, travel
expenses for FY 2004 have not yet been reported.

This review was performed at the BeckleyFinanceCenter
in Beckley, West Virginia,
and the IRS Agency-Wide Shared Services and IRS Oversight Board offices in Washington, D.C.,
during the period December 2004 through February 2005.† The audit was conducted in accordance with Government Auditing Standards. †Detailed information on our audit objective,
scope, and methodology is presented in Appendix I.† Major contributors to the report are listed
in Appendix II.

The DO provides the administrative support, such as the
recording of financial transactions, necessary for the Oversight Board to
function.† The DO also provides the
Oversight Board with monthly Financial Status Reports for use in managing its
operating funds.† The monthly Financial
Status Reports detail both available balances in major spending categories and
budgeted amounts.† Timely and reliable financial management
information is critical to effective program management.

Our review of the activity reflected in these Reports for FY
2004 identified a number of instances where material financial transactions were
either misclassified or not properly reflected.†
For example:

Communication consulting fees of
approximately $86,000 for services provided to the Oversight Board in FY
2004 were not reflected as expenditures in the Financial Status Reports.†

Communication consulting service
expenditures of approximately $15,000 were classified as fees paid to
agents for the redemption of savings bonds.†

Outside contractor service expenditures to
conduct public surveys and provide communication consulting services totaling
approximately $2,300 were classified as medical services.

Outside contractor fees of approximately $26,000
to conduct public surveys and provide communication consulting services in
FY 2004 were not reflected as expenditures in the Financial Status Reports.

As a result of these
errors, consulting expenditures were understated by approximately 72 percent.† In addition, Oversight Board member
compensation of approximately $143,000 for FY 2004 is not reflected as an expenditure
in the Financial Status Reports.† These
omissions resulted in Oversight Board salary expenditures being understated by
approximately 16 percent.

These errors can largely
be attributed to a lack of adequate internal controls.† For example, the Oversight Board has not
established any formal procedures or guidelines requiring the routine review of
its monthly Financial Status Reports for misclassified items or significant
variances between expected and actual expenditures.† The Oversight Board also has not established
any formal procedures or guidelines requiring the tracking and monitoring of
its open aged obligations. †The Oversight
Board informed us that the DO does
not routinely provide it with information regarding transactions related to open
aged obligations.

Inaccurate or incomplete
financial management information impairs the ability of the Oversight Board to
readily monitor the availability of funds remaining for the procurement of
future services and compromises the ability of the Oversight Board to establish
a reliable baseline when estimating future budget needs.† In addition, the ability to timely deobligate
unneeded funds and use them for other purposes is adversely affected by the
lack of complete and reliable information about expenditures.† Appendix IV presents details on the
reliability of information outcome measure resulting from the identification of
these errors.

While the Oversight Boardís approved FY 2004 budget of $1.5
million is not large in comparison to the IRSí total budgetary resources of
approximately $11 billion, controls still need to be in place to properly
manage and account for Oversight Board operations.

1.Develop procedures requiring that monthly reports
reflecting Oversight Board activity be routinely reviewed for misclassified
items or significant variances between expected and actual expenditures.† Any discrepancies identified should be
researched and resolution coordinated with the DO.

Managementís Response:† Procedures have been developed for Oversight
Board staff to conduct a monthly review of all monthly cost reports prepared by
the Department of the Treasury Office of Financial Management (OFM) and
identify misclassified items or expected but unreported expenditures.† The procedure has been coordinated with the
OFM to ensure it will timely support the resolution process.† The Board Chairperson and Staff Director will
quarterly review the status of the Boardís expenditures.

2.Develop procedures, in coordination
with the DO, requiring a) the
ongoing preparation of management information regarding open aged obligations
and b) the tracking and monitoring of these obligations.

Managementís Response:† Procedures have already been developed for
Oversight Board staff to conduct a monthly review of open aged
obligations.† The procedures have been
coordinated with the OFM, which has agreed to provide the Oversight Board with
such a report monthly and to timely respond to Board inquiries.

The DO advances the Oversight Board the funds necessary to
meet its ongoing obligations.† The DO is
subsequently reimbursed for these costs by the IRS quarterly.† The detailed terms of this reimbursement
process are contained in an Interagency Agreement between the DO and the
IRS.† As part of this Agreement, the Chairperson of the Oversight Board, or his or
her designee, is required to certify as reasonable and necessary all costs
submitted to the IRS for reimbursement. †The Interagency
Agreement is updated annually.†

The requests for
reimbursement in FY 2004 that we reviewed were not certified as to their
accuracy by the Chairperson of the Oversight Board, or his or her designee, nor
were they reconciled to the Oversight Boardís monthly Financial Status Reports
to ensure accuracy and completeness.

Our review of the
reimbursement requests submitted to the IRS for FY 2004-related expenditures
indicated that, in general, they mirrored the activity reflected in the
Oversight Boardís monthly Financial Status Reports.† However, as discussed previously, these Reports
contained material errors.

The Oversight Board
informed us that the DO prepares the reimbursement requests from the financial
transactions of the Oversight Board, which it maintains on its accounting
system, and sends them directly to the
IRS.† Without a timely and careful review
of these reimbursement requests, the Oversight Board cannot be assured that
they are complete, accurate, and contain only charges related to the operation
of the Oversight Board.

3.Develop procedures requiring that all requests for
reimbursement be forwarded to the Oversight Board for review and certification.

Managementís Response:† Procedures have been developed for Oversight
Board staff to certify quarterly requests for reimbursement submitted to the
IRS.† The OFM has adopted a companion
procedure to submit these requests to the Staff Director, IRS Oversight Board,
prior to their submission to the IRS.†
The Oversight Board will reconcile each request with the financial
reports for the months included in the request and, once reconciled, will so
notify the IRS by memorandum.

Federal Government travel
regulations require that travelers reduce their meals per diem whenever the Federal
Government provides meals at no cost.†
Additionally, Federal Government travel regulations specify that
travelers may receive reimbursement for actual travel expenses only when
necessary due to the unusual circumstances of an assignment.† However, Oversight Board members did not
always adhere to the regulations when performing official travel.† For example:

∑Oversight
Board members received both a no-cost meal provided by the Federal Government
and a per diem cash payment for the same meal in 36 instances in FY 2004.† The Staff Director, IRS Oversight Board, informed
us the meals were provided in conjunction with Oversight Board meetings.† The per diem payments generally ranged
between $10 and $26, depending on the type of meal, and totaled approximately
$485 for FY 2004.†

∑A new Oversight Board member
incurred lodging costs which significantly exceeded the maximum allowable costs
reimbursable by the Federal Government under Federal travel guidelines.† The excess expenditure was reimbursed by the Federal
Government.† The Oversight Board member
was attending a regularly scheduled Board meeting and indicated that he was
unaware of the reimbursement guidelines.

These issues can be attributed to a number of factors,
including unfamiliarity with the unique nature of Federal Government travel
regulations and the absence of formalized communication procedures for the
orientation of new Oversight Board members.†
Lack of consistent adherence to Federal Government travel regulations
could result in disparate treatment of Federal Government travelers and
inappropriate use of Federal Government funds.

4.Reinforce Federal Government
travel guidelines regarding meal reimbursement to all current members† and ensure new and incoming Board members are
provided instructions on relevant key Federal Government travel regulations
before they incur travel expenses.†

Managementís Response:† The DOís Travel Handbook has been distributed
to all Board members and staff by the Oversight Board Chairperson.† With new Board members likely to be nominated
shortly, the Travel Handbook will be incorporated into a Board Orientation
Guide for new members.

The creation of the IRS
Oversight Board was part of many changes in the IRS mandated by the RRA
98.† The RRA 98 specified the duties and
responsibilities of the Board, as well as its organizational structure, and set
its size at nine members.† The Oversight
Board was specifically designed to be an independent body responsible for
providing the IRS with long-term guidance and direction. †The
operation of the Oversight Board is funded by the IRS based on a proposed
budget submitted annually by the Board.

The DO provides administrative support to the Oversight
Board and advances it the funds necessary to meet its ongoing obligations.† The IRS subsequently reimburses the DO for
these costs quarterly, based on an Interagency Agreement.† The Interagency Agreement requires annual
approval by the IRS and specifies the maximum funding level of the Oversight
Board for the year.

Our review indicated that the process used to establish the
annual funding of the Oversight Board needs to be improved.† In our
opinion, the Oversight Boardís apparent dependence on the IRS for approval of
its annual budget has the potential to adversely affect its independence and
effectiveness. †Specifically, the IRS
could be perceived as potentially having undue influence over the entity
established to independently oversee its administration and management.† The RRA 98 does not specify a
methodology for establishing the annual funding level of the IRS Oversight
Board.†

5.Request
that the Department of the Treasury establish a separate line item within its
budget for the funding of the Oversight Board.

Managementís Response:† The Chairperson shall discuss with the
Department of the Treasury appropriate mechanisms for funding the IRS Oversight
Board to assure its independence from the IRS.†
The Board notes that the House Appropriations Subcommittee on
Transportation, Treasury, and Housing and Urban Development; the Judiciary; and
the District of Columbia
have recently addressed this issue in the committee report for the FY 2006
appropriation bill by specifying $1.5 million for the operations of the IRS
Oversight Board.

The overall objective
of this review was to evaluate the extent and adequacy of controls over the
budgeting of funds, recording of transactions, and financial reporting of the Internal
Revenue Service (IRS) Oversight Board.† We
also reviewed the IRS Oversight Boardís Fiscal Year (FY) 2004 financial
transactions.†
This review was conducted
as a follow-on to our recently completed audit of the effectiveness of the
Oversight Board.† To accomplish this
objective, we:

I.Evaluated
the methodology used by the IRS Oversight Board to formulate and monitor
its annual operating budget.

A.Interviewed the
Oversight Board Chief of Staff to determine how the annual operating budget was
established, approved, and monitored.

B.Evaluated the FY 2004
budget, determined whether it was reasonable in comparison to actual
expenditures for FY 2003, and investigated line items with significant
variances.

C.Determined whether
execution of the FY 2004 budget was effectively monitored and investigated any
FY 2004 line item expenditures that varied significantly from the budgeted
amounts.

This appendix presents detailed information on the
measurable impact that our recommended corrective actions will have on tax
administration.† This benefit will be
incorporated into our Semiannual Report to the Congress.

We found a number of errors in the Fiscal Year (FY) 2004 accounting
records of the Internal Revenue Service (IRS) Oversight Board and control
weaknesses that could prevent the Oversight Board from timely identifying
transactions that are misclassified or not properly recorded.† The outcome measure recorded represents the
aggregate amount of the errors we could identify, which consists of
approximately $272,000 shown in the report and an additional $7,000 in various
miscellaneous expenses.† Because the IRS
Oversight Board did not have effective controls over the accuracy and
reliability of information in its records at the time of our review, we were
unable to readily determine the precise amount of Oversight Board expenditures
related to its $1.5 million budget for FY 2004.†
We define the reliability of information as ensuring the accuracy,
validity, relevance, and integrity of data use.